This downward pricing trend, however, was not a crypto-specific phenomenon. 2022 was a year that saw dramatic volatility and downward price pressure across all financial markets and asset classes due to a number of prevailing factors such as: war, further east-west polarization, further fallout from the Covid-19 money printing and concerns around a global sovereign debt crisis. Cryptoassets are not isolated assets, but in fact highly correlated macro assets.

Having said that, the last 12 months has seen the total crypto market capitalisation drop from ~$3 trillion to $~800 billion... With the most notable asset, Bitcoin, having dropped from an all-time high of $67,734 in November 2021, to drifting around $16,000 before the start of the new year. Whilst these are meaningful corrections, its important to note that similar drops in percentile terms have been replicated across a number of other mature asset classes.

Whilst much of what we are experiencing reflects macro trends and factors, there have also been some high profile, industry-specific events that have unfolded in 2022, and continue to do so. They have shone a particularly bright light on the cryptoasset ecosystem, highlighting some areas in drastic need of attention for this market to move beyond what it has been to date — broadly offshore, speculative, and retail driven.

The Contagion begins

Looking back on the year past, it has become clear that the implosion of the algorithmic stablecoin TerraUSD, which eviscerated a reported $60 billion in value almost overnight, was the first domino to fall that kickstarted a cascading series of liquidations, bankruptcies and related events. The downfall of $UST and the projects associated ‘governance’ token $LUNA led to significant fallout amongst many of the space’s largest players. Three Arrows Capital (3AC), one of the largest crypto hedge funds managing a reported $10 billion AUM at its peak, was soon at the centre of the market meltdown. The fund was overexposed and overleveraged leading to insolvency, in what originally was framed as cavalier decision making and poor risk management but quickly morphed into accusations of malfeasance and fraud by creditors and regulators alike.

Contagion is a very real phenomenon and the liquidity crisis and unravelling of leverage continued to spread and accelerate across the crypto ecosystem with centralised lenders Celsius and Voyager becoming casualties and Blockfi also being impacted. Poor risk management, a lack of corporate governance and excessive leverage are a combination that have historically been catastrophic as markets take a downturn, irrespective of the asset class. The crypto ecosystem and its participants are no different.

Whilst centralised lending platforms seemed to be the ones in danger, centralised crypto exchanges had remained seemingly unaffected by these events and one in particular, FTX, and its vocal and visible leader Sam Bankman-Fried (commonly referred to as SBF) emerged as the industry’s “white knight” during this difficult period. FTX spent time and money bailing out some of the aforementioned businesses that were imploding, helping to shore up confidence in the space.

However, this façade of stability and liquidity has proven to be just that... With a spectacular unravelling seen over the last month. FTX, the world's second largest exchange by volume and its associated market making operation Alameda Research, have filed for Chapter 11 bankruptcy protection (along with 130 other affiliated companies) and the information that continues to come out around the firm and its management is extremely damning for the individuals involved and more importantly the industry as a whole. The FTX founder and ex-CEO Sam Bankman-Fried went from being a crypto-darling amongst politicians, regulators and venture capitalists to an industry villain and suspected fraud within the space of a few days. At time of writing there is a ~$12b hole associated with FTX / Alameda, with over a million associated creditors and it’s becoming increasingly clear that amongst a gordian knot of allegations and wrongdoings FTX used customer funds to finance Alameda’s activities, a cardinal sin across financial markets.

Bankruptcies, court cases and intervention from Interpol have only just begun and we expect associated litigation will be part of the crypto narrative in the years ahead. These events are certainly damaging but highlight the need for better regulation and infrastructure from more traditional providers with proven track records in servicing the wholesale markets from recognised jurisdictions. Whilst this paints a particularly dark view of cryptoassets, it is only one side of the 2022 story.

In defence of cryptoassets and DeFi

In the first FTX hearing at congress and in media interviews surrounding it, crypto-aware senators such as Tom Emmer, Pat Toomey and more, made the poignant point that it is not Cryptoassets on trial here. But instead that the failings of FTX are due to greed and the centralisation of power without sufficient oversight or regulatory scrutiny. Blockchain and cryptoassets were created specifically to solve for the problems of centralisation, control and obfuscation by being public, immutable, transparent and decentralised. They allow for clear auditable records and transaction tracking, that in the case of FTX allowed for the crypto community to uncover the fraud of FTX and Alameda far before any regulator or governmental body was even aware or able to intervene in any meaningful capacity.

To mar a progression in technology, based-off the actions of greedy, naive or incompetent bad actors would be a mistake, but one that many will still likely make. When the dotcom bubble burst, many conflated the surrounding nascent ecosystem, business' and actors as the sum of the whole and labelled the internet as simply another passing fad. What they missed was the fact the underlying technology that allowed for this momentary business boon was in fact revolutionary and capable of far more than the standard joe could conceive at the time. The internet allowed for the disaggregation of major media behemoths and a revolution in communications that touched the entire globe. Its changed the face of the world and moved far beyond communications to revolutionize how business is done in almost every sector. With Cryptoassets and smart contracts we are seeing the early stages of a new web of value emerging. One that we believe will not only affect how every financial asset is transacted, settled and stored. But come to affect almost all business models in time, just as the internet revolution in information/ data distribution has.

One area that has seen significant growth and development is DeFi, with on-chain innovations such as tokenised assets and smart contract technology opening up a wealth of new opportunities for investors. The ability to tokenize traditional assets and trade them on decentralized exchanges, as well as the implementation of automated lending and borrowing protocols, creates a new level of accessibility and versatility for retail and institutional investors alike. Allowing not only for the creation of new and exciting investment opportunities, but also the ability to access these opportunities in a more efficient and cost-effective manner.

This new smart, automated and interconnected monetary building block system is already attracting serious  Institutional attention. With major banks such as JP Morgan and DBS using a modified version of Aave and Uniswap to test tokenised FX and bond transactions, Goldman Sachs rolling out their own exchange for tokenised assets, KKR tokenising its Health Care Strategic Growth Fund II on the Avalanche blockchain and countless other examples. Furthermore we have also seen important collaborations and partnerships emerging between Crypto firms/ platforms and more traditional finance and distribution participants such as Chainlink's new collaboration with the SWIFT network or recently ABN Ambro and the Israel Ministry of Finance partnering with Fireblocks to issue digital bonds on public ledgers.

This is just the tip of the iceberg. 2022 has seen the likes of Point72, Brevan Howard, Citadel, Millennium and Blackrock and more making strategic investments in cryptoassets and setting up desks and entire subsidiaries to operate in the space. Its clear that the capital allocation towards this burgeoning ecosystem in the coming years is set to grow significantly. However, in order for cryptoassets to deliver on the promise of this emergent technology, its clear that what it needs most is stability, great clarity and a strong foundation to build and invest from. This cannot be achieved without a proper globally recognised regulatory framework. The existence of which will lay the doubts of the long-term viability of this asset class and technology to rest, protect users and investors alike and threaten those who seek to use this technology for illicit means. 2023 could indeed be a transformative year for the digital asset space.

As always please send any feedback, suggestions or comments to the Team mailbox.

Best Oliver Wink and Simon Forster on behalf of the Digital Assets team.